Quarterly Outlook: US Macro Outlook Still Solid, But Cracks Starting To Show

US economic activity growth is solid but slowing, with high frequency data across the corporate and consumer sectors showing an increasingly mixed picture.
We at Fitch Solutions believe that the Federal Reserve is not quite done with monetary tightening, as more favourable market and global economic conditions alongside a still-tight labour market will prompt a final 25 bps increase to 2.50-2.75% in the latter part of 2019.
Broad legislative gridlock is likely to persist through 2020 given a split Congress. The potential for brinksmanship from both parties, particularly with a negotiation on the debt ceiling on the horizon, could undermine consumer or business confidence.
Economic Activity: Real GDP growth will slow in 2019 as the effects of the 2017 fiscal stimulus fade and tighter credit conditions crimp business and consumer spending. Our forecast of 2.5% real GDP growth, down from 2.9% in 2018, suggests that growth will remain above trend. That said, there are downside risks to our 2019 growth outlook (see ‘US Growth To Slow In 2019, Watching Downside Risks’, March 5). Increasingly mixed high frequency economic data and weaker corporate earnings suggest there are growing stresses consistent with the late stage of the economic cycle.

Political Outlook: We expect broad legislative gridlock through 2020 given a split Congress (see ‘Divided US Government Will Lead To Policy Gridlock’, October 23 2018). Democrats are likely to use their control of the House of Representatives to pass legislation that is popular with their base but unlikely to pass in the Senate. They will also use their oversight powers to launch investigations into the administration of President Donald Trump. Republicans in the Senate are likely to prioritise judicial appointments. The dispute between Trump and Democratic leadership that resulted in a 35-day government shutdown beginning in late December is indicative of the legislative stalemate that is likely to prevail through 2020 (see ‘US Set To Avert Shutdown, Legal Battle Ahead’, February 15). This, combined with the potential for brinksmanship on both sides, could have potential negative consequences for consumer and business confidence in the quarters ahead. This is particularly pertinent with a debt ceiling negotiation coming up in the months ahead.

Exchange Rate Policy: We maintain a neutral outlook on the US dollar (USD), expecting that widening twin deficits and a more dovish stance by the US Federal Reserve will cap USD strength. Increased uncertainty in the outlooks for G10 economies will also prevent any significant strengthening of these currencies against the USD (see ‘USD: Dollar At A Crossroads’, January 2). However, upside risks to our neutral USD view have risen in recent months (see ‘Upside Risks To Our Neutral Dollar View’, March 15). A sustained rebound in US economic data, which has disappointed in recent months, could renew potential for a resumption of the Fed’s hiking cycle in H219, fueling USD strength. Conversely, growing signs of weakness in the US economy could spur a flight to safe-haven assets, benefiting the USD alongside the Japanese yen and Swiss franc, among other assets.

Monetary Policy: The Fed has turned increasingly dovish over the course of its last two meetings, and we now see one 25 bps rate hike before end-2020 (see ‘One Fed Rate Hike Between Now And End Of 2020’, March 22). Our baseline forecast is for this to take place by end-2019. We believe growth will pick up from Q219, which, combined with a still-tight labour market, will see the Fed enact one hike at the end of Q319 or in Q419. With growth set to slow further in 2020, we forecast no hikes in 2020, a downward revision from our previous forecast for two rate increases to 3.00-3.25%.

Fiscal Policy: US fiscal policy will remain expansionary over the coming years, with the budget deficit set to widen from 3.8% of GDP in 2018 to 4.9% in 2019 (see ‘US Fiscal Deficit To Remain On Widening Trend', April 2). Spending growth will remain robust on the back of rising mandatory spending commitments, as well as increased defence spending and debt servicing costs. Meanwhile, revenue growth will continue to underperform spending growth, as economic activity slows and the impact of the 2017 Tax Cuts and Jobs Act continues to affect income and corporate tax intakes.

Expansionary Fiscal Policy Set To Continue

US - Revenue, Expenditure, Budget Balance

f = Fitch Solutions Forecast. Source: CBO, Fitch Solutions

Given these dynamics, debt levels will climb further in the coming years, with gross debt set to reach 78.5% of GDP in 2019 and 80.0% in 2020, up from 77.0% in 2018. This will limit the US government’s fiscal policy flexibility over the medium-to-long term, reducing its ability to support the economy in a downturn, and potentially beginning to crowd out private investment and stoke inflationary pressures (see ‘US Fiscal Deficit To Widen As Economic Growth Decelerates’, December 14 2018).

Balance of Payments: The US’s current account deficit will widen over the next few years. A relatively strong dollar by historical standards and the US’s low private and public savings rates relative to its major trading partners are major factors driving this trend (see ‘Cyclical And Structural Factors Will Widen The US Current Account Deficit’, September 28). We forecast the current account deficit to widen from 2.4% of GDP in 2018 to 2.6% in 2019 and 2020.